Description

TravelCenters of America LLC (TA) was written up in February by madler934; since then the stock price has declined significantly, while the intrinsic value per share of the company has substantially increased.  It is hard to envision losing money in the stock at current prices, and I will describe a reasonable scenario where the stock price increases significantly over the next few years.

 

Please review madler’s report for background and historical performance.  I will summarize my investment case below.

 

BUSINESS

TA operates and franchises travel centers under the “TravelCenters of America,” “TA” and “Petro” brands primarily along the U.S. interstate highway system. Customers include long haul trucking fleets and their drivers, independent truck drivers and motorists.

In 41 U.S. states and in Canada, the company operates 187 travel centers and franchisees operate 46, including ten travel centers which franchisees sublease from TA and 36 travel centers which franchisees own.

Travel centers typically include 20 to 25 acre sites and provide customers with diesel fuel and gasoline as well as nonfuel products and services such as truck repair and maintenance services, full service restaurants, quick service restaurants, travel and convenience stores and other driver amenities. TA also collect rents and franchise royalties from its franchisees.

Hospitality Trust (HPT), a publicly traded REIT, created TA in order to operate the travel centers whose real estate assets it owned, and distributed TA shares to HPT shareholders in a spin off transaction effective January 31, 2007.  TA leases the bulk of its real estate assets from HPT under a contractual fixed lease agreement with built-in annual increases.  In addition, HPT has agreed to reimburse TA for its capital improvements, up to a total of $25 million per year for a total of five years, and may act as a financing partner for TA in its future acquisitions.

SIGNIFICANT CHANGES SINCE FEBRUARY

 

In May 2007, TA acquired one of its major competitors, Petro, at a very attractive price of 4.1x pro forma EBITDA.  HPT acquired Petro’s real estate assets in conjunction with the transaction.

 

TA issued a significant amount of stock (5.3 million shares) at over $41 per share in July 2007, substantially improving its balance sheet and tangible book value.  Note that the company had 8.8 million shares outstanding before the stock issuance.

 

VALUATION

 

On June 30, 2007, TA had cash of $152 million and restricted investments of $276 million, which will be used to pay off assumed Petro notes in February 2008.  The pro forma net cash balance on June 30 (adjusting for $206 million in proceeds from the July secondary) is $358 million. (Please note that the capital lease obligations are an accounting creation, as discussed in the earlier write-up and confirmed by the company in its conference calls).

 

 

Instead of projecting future operating performance of TA, I turned the question on its head …. What do TA’s EBITDAR margins have to be to justify a higher stock price?  I use contractual rent for 2009 in the calculations below:

 

TA stock price		$26	$36	$46	$56
Shares outstanding (MM)		14.2	14.2	14.2	14.2
Market value ($MM)		$370	$512	$654	$796
Less: net cash ($MM)		-358	-358	-358	-358
Enterprise value ($MM)		12	154	296	438
EV/EBITDA		6.0 x	6.0 x	6.0 x	6.0 x
Implied EBITDA ($MM)		$2	$26	$49	$73
Rent ($MM)		250	250	250	250
Implied EBITDAR ($MM)		252	276	299	323
Revenue ($MM)		6,700	6,700	6,700	6,700
EBITDAR margin		3.8%	4.1%	4.5%	4.8%

 

For comparison purposes, TA EBITDAR margins in 2006, pro forma for the Petro acquisition and one Petro travel center open now but not in 2006, were 3.9%.  TA has recently begun “Operation Refresh”, which will invest $125-150 million over a few years to upgrade facilities.  This investment will be primarily funded by HPT at $25 million per year for five years under a contractual agreement.  If this $125 investment generates an ROI of 20%, or $25 million per year, this would increase EBITDAR margins by 0.4%.

 

Essentially, at today’s price, shareholders are paying net cash value for the company, and getting a free option on operating improvements on a large revenue stream.  As long as EBITDA remains positive on average over the next few years, shareholder downside is extremely limited, while the upside is quite large.

 

RISKS

 

Due to the fixed nature of its lease payments, TA has been transformed into a business with high operating leverage, which can cut both ways.  In a declining economic environment with declining truck volumes, margins will be squeezed and profitability will decline.  I believe these concerns are already reflected in the stock price.  In addition, this environment should lead to further acquisition opportunities for the company, with its strong balance sheet, large size and financing partner.  One litmus test I have used for long term winners is whether they emerge from an industry downturn with increased or reduced market share.  I believe TA will emerge a winner.

 

There are inherent conflicts of interest between TA and HPT.  The most relevant of these is that HPT wants to maximize the credit quality of TA (a very significant customer), which may prevent TA from conducting share repurchases at currently depressed prices.

 

TA is undertaking certain capital projects that should improve the physical facilities at its travel centers, and is choosing to accelerate these improvements during the cyclical downturn, which should minimize customer disruptions.  While the company believes it will earn an attractive return on these investments as measured by increased market share, revenues and margins, we will not see the results until after the capital has been expended.

 

 

Catalyst

The company’s third quarter conference call in mid-November should provide a clear focus on the balance sheet (reflecting the secondary stock issue in July) and some third quarter cost reduction efforts. Additionally, tax loss selling (the stock is at year-lows) should abate as year end approaches.